You can almost smell it in the air ahead of the start of the next earnings season: more fear than the normal, and right before the April 30 Federal Reserve decision. Biotech names have been selling off. Names that light up social feeds, such as Tesla (TSLA), Facebook (FB), Netflix (NFLX) and Twitter (TWTR), are getting routed as institutional investors try to shake out the suckers. Even the rotation into value stocks must now be watched like a hawk amid heightened risk for a full-fledged move of money to the sidelines.
Here are three problems this fear has caused.
First, if a company soundly beats on earnings, are its shares being sold simply because the market is pulling back? For example, Micron (MU) reported solid earnings last week and the stock popped in response, but then it closed down 6%. That kind of action is disturbing, suggesting that investors have grown concerned even about holding companies with positive things to tell the world.
Second, if a company actually misses on earnings, and if the stock has already declined a fair amount ahead of the report, it could very well get battered once again. Such action may unfold in the high-multiple sectors of the market, affecting such stocks as -- again -- Tesla, Facebook and Twitter.
Third, the market has been holding out hope that the second quarter has started off hot for many companies. So if a company suggests on its earnings call that this is not the case, chances are that the stock will be walloped, even if the first quarter looked OK.
In short, there is more risk than reward at the beginning of earnings season. Here are a few more ins and outs.
• Let the momentum names live up to their name. In other words, allow the companies report some good numbers and positive commentary, and then watch to see if buyers scoop up the shares at much cheaper valuation levels vs. three months ago. Note: Facebook shares did surge on Jan. 29 when the company announced fourth-quarter numbers.
• Look for names that could show outright booms in their results and offer positive commentary. Three examples: Dick's Sporting Goods (DKS) Home Depot (HD) and Under Armour (UA), all of which are benefiting from improved weather in mid-March. In the case of Home Depot, lawns and gardens -- and sidewalks -- were destroyed by the weather, and investments will need to be made.
• The retail sector, by and large, is set to announce poor quarters. In this sector, April needs to be huge, according to executives with whom I am speaking. In other words, spring has to arrive already. In any case, given the pressure on margins from unplanned markdowns on seasonal merchandise, I would stay clear of Wal-Mart (WMT), Target (TGT) and teen-apparel names such as Aeropostale (ARO) and American Eagle Outfitters (AEO),
• Stay away from the companies with a good bit of China exposure. China looks bound to suffer from an economic slowdown, so China-exposed companies -- among them, Nike (NKE) -- will carry currency risk in coming months from. So, instead of buying these, stay in the industrials -- such as Snap-On (SNA) -- that are playing in the still-ongoing European recovery.
• Wildcard sector: homebuilders. Although these stocks have been outperforming the major indices during the recent pullback, earnings-call commentary needs to be strong to justify their relative outperformance. Do not head to lower-quality players in the space, such as Beazer (BZH) and Pulte (PHM). Toll Brothers (TOL) is one of your better bets on spring housing recovery.
